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Combine healthcare and tax reform to bring out the best in both

As it mulls the House's American Health Care Act (AHCA), the Senate can make passage easier and make results better on multiple fronts by thinking creatively and conjoining health and personal income tax reform. The resulting synergies can produce the strongest market-based approach to healthcare, while simultaneously strengthening the case for the tax reform needed to energize the American economy.

The AHCA's tax credits for those without employer-provided insurance, while costly for the treasury, are too small to induce many healthy young people to purchase insurance and are far too small to enable many older people to afford it.

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Meanwhile, the bill ignores the elephant in the room: the massive subsidy in the form of the exclusion of employer-paid health benefits from employees' taxable income. That subsidy is open ended — the more you spend on health insurance, the bigger your subsidy. Since World War II, that has encouraged over-insurance and discouraged attention to costs.

It has been the biggest contributor to dysfunction in the healthcare market. It is also highly regressive: It is much more valuable to the affluent, who have higher marginal tax rates and, in many cases, more expensive insurance. Only people with employer-provided coverage get the subsidy.

The best achievable healthcare reform would end the exclusion and use those subsidy dollars for a universal health credit for all those not in government programs, like Medicare and Medicaid. The credit amounts would be based on the costs of insuring people in different insurance rating categories.

Most important, credits would be fixed, not open-ended. They would support basic health insurance, but at the margin, consumers would be spending their own after-tax dollars if they wanted to buy additional coverage.

There are three ways to increase the pot of money available for the credits while still achieving budget savings overall. First, use a portion of the dollars in the budget for the Obamacare subsidies. Second, avoid a windfall for Social Security and Medicare by applying a “health credit financing tax” equal to and substituting for the FICA taxes that would otherwise apply to the newly-created taxable income in the form of employer-paid healthcare benefits.

Third, use the cost of health savings accounts, which are regressive and would no longer serve a useful function. That's a smaller amount of money not vital to the reform and would cause reflexive consternation in some quarters but should at least be considered.

With these enhancements, the credits can be very robust — enough to pay the complete premium for a basic health plan in the individual market — so there would be no reason for healthy people not to sign up, and the number of people insured would increase (imagine the reaction to that CBO report!). Also, robust credits would make it easier to transition people off Medicaid, thus supporting the Medicaid reforms in the AHCA.

In that way, they would also help solve the poverty trap problem, which is the sky-high marginal tax rates poor people face as they lose welfare benefits, including Medicaid, if they increase earnings or get married. For those who retain employer-negotiated coverage, the more robust their credit, the better deal it is compared with an exclusion.

Combining overall personal income tax reform with these reforms of health-related tax provisions brightens the picture. The prospective tax reform will lower tax rates across the board. But the more rates are lowered, the better a credit looks compared to an exclusion of income from taxation.

For those who keep employer-provided coverage (which many companies will continue for various reasons), robust credits combined with lower tax rates can mean that a majority of employees will get a better deal from a credit than from the exclusion.

The lower the rates and the better the credit, the larger that majority will be. That's a powerful argument for the reform package. At the same time, since their subsidies are no longer open-ended, employees will no longer have an incentive to bargain for over-generous health benefits rather than increased wages.

While gaining like everyone from a better health market, the big losers in the rearrangement of subsidies will be wealthier people, including business executives and well-paid labor leaders who have traditionally opposed it. However, what they lose in the health reform they will gain back in the tax reform, so they should support a combined package.

On the other hand, a principal argument against the tax reform will be that it helps the rich, but that is blunted by what they lose on the health side, so the case for the tax reform is strengthened. The case can be strengthened further by reforming child credits to make further progress on the poverty trap. What better argument is there for the tax reform than lowering the highest marginal rates of all: those faced by the poor?

The AHCA relies mainly on competition among deregulated health plans to improve the market. But we can do much more to involve individual consumers in the effort. Maximizing consumer-driven market forces requires that most consumers face significant cost sharing, that they can find out prices charged and that prices matter to them.

The bolder reforms suggested here will produce the cost sharing. Mandatory price disclosure may have to wait for a following bill or regulation. Finally, price sensitivity at the margin will result if non-HMO health plans base their payments on median prices charged in a market, with consumers enjoying savings or paying extra for choosing providers charging less or more than the median.

With these reforms, consumers will have incentives to avoid unnecessary services and to be value-conscious about the services they need.

Even some Democrats should support a health/tax package that doesn't favor the rich and maximizes market forces in healthcare while improving on Obamacare's support for the individual market and distributing healthcare subsidies fairly across the population. Then, if the best possible market-based approach somehow doesn't work, their case for a single-payer health system will be stronger.